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As an EU resident, I am not allowed to purchase US-based ETFs. However, I am allowed to trade in options on such ETFs and exercise them.

One way of obtaining the stocks I would want to purchase is by purchasing a synthetic (long call + short put at same strike and expiry) and letting it expire.

Could you help me understand the risks and additional costs involved in doing this? I would like to compare them and their risks and costs to other alternatives: index futures, EU-based ETFs, CFDs (with my current broker), CFDs (with eToro)

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  • Could you just buy an in-the-money call that expires end of the week, and - bam! - you get them assigned, and have them? – Aganju Dec 23 '20 at 5:33
  • @Aganju Yes, but even the time value of a few days can be quite significant, so I can offset that by selling the put. Plus, for some stocks, there aren't any options expiring soon; I'm looking at VGT and earliest expiry is 15 Jan; whereas if I hold the synthetic, I instantly start replicating the value of the underlying as soon as the trade is complete – Gabi Dec 23 '20 at 11:22
  • The core idea of the synthetic is that the time premium received for the put sale pays for most/all of the time premium paid for the long call. The positive put delta (short negative delta) and the long call delta adds up to 1.00 which replicates the delta of long the underlying. – Bob Baerker Dec 24 '20 at 22:17
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What are the risks involved in buying a synthetic long (long call short put) and letting it expire compared to buying the underlying?

If the underlying expired ITM or OTM. you'd be assigned. The only possible way that the two options would expire worthless would be if the underlying closed exactly at the synthetic's strike at expiration and that's rare.

The additional costs involved in a synthetic long would be multiple bid/ask spreads and extra commissions if you're still paying them (US investors can trade with no commissions).

The only other issue is the comparison of the synthetic long's purchase price versus the current price of the stock. For example, with TSLA at $630, the Feb 19th $630 synthetic long would cost 50 cents (B/A spreads are wide so working the combo should get you a better price). Therefore, your cost basis of stock if assigned would be $630.50 . If a stock pays a dividend prior to expiration, make sure to include it in your calculations.

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  • Thanks! And I would think, even if it closed exactly at the synthetic's strike at expiration and that's rare, I do still hold my right to exercise my call, right? I mean, that right might have a value of $0 for someone able to buy the underlying, but I'm not able to buy the underlying and so I should still be able to exercise it; but maybe the broker wouldn't automatically do it – Gabi Dec 23 '20 at 11:24
  • Closing exactly at the strike (Pin Risk) is indeed rare. If these are American options, it's also possible that you are assigned before expiration. You hold the right to exercise your call until they expire. Note that the OCC (not your broker) will exercise any option that expires one cent ITM (Exercise By Exception) but per posts by some, it appears that a few may slip through the cracks. If your intent is to utilize the less capital intense synthetic then roll your existing position just before expiration to avoid assignment. – Bob Baerker Dec 23 '20 at 11:56
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You would think that a synthetic long/short would replicate the underlying asset with the same payoff structure. However, due to bid/ask spreads, especially on less liquid products, the payoff will be inferior. In fact, if you put on a synthetic long and then shorted the stock, or vice versa, thereby having a totally delta hedged position, you would be automatically locking in a loss, simply because of the bid/ask spreads.

In addition, if you are assigned on any leg, you would have to have the resources on hand to cover that assignment. E.g. if you are assigned on the short put leg, you would need cash on hand, which you probably wouldn't be able to get by selling your calls, since the value of the calls would decrease. If you are assigned on the short call leg, you would need to have enough to buy the stock.

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    An inferior payoff isn't 100% set in stone. You can buy short term long synthetics on liquid securities such as the SPY for pennies and sometimes with minute to minute fluctuations, for even money. One also needs to factor in the lack of carry cost. Given that the question is about a comparison of buying the underlying to the synthetic long, tho modest, the synthetic collects interest on the uninvested principal. – Bob Baerker Dec 22 '20 at 18:15

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